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Thursday, October 30, 2014

What Is A CEO Worth–Or Any Of Us For That Matter?

There has been a lot of flap recently about executive pay and how it has ‘gotten out of hand’; yet the salary-and-benefits packages are not decided by senior executives themselves but by boards of directors.  They decide whether or not the remuneration offered to top executives is worth it.  

Since there is no x/y equation to plug in performance and spit out salary levels, firms and their boards must make often very subjective judgments as to worth and value.  While objective criteria form the basis for selection, and past performance regarding corporate profitability, labor management, financial savvy, etc. is scrutinized very carefully, subjective judgment will always come into play. Corporate bunglers sneak in under the vetting radar all the time.  The genius at Sewickley Ball Bearing may not be able to transfer his skills to mining or software.  The fact that he raised the profitability of his former company by 50 percent in two years, cleared employee dead wood while neutralizing difficult unions, and negotiated risky Wall Street investments without ultimate liability, does not mean he can do the same in a different environment. 

The board of directors seeking to hire him may have been so impressed by his categorical successes that they overlooked the facts that in their state the Attorney General was on a tear, the IRS increasingly nosy, the labor unions among the most powerful in the country, and the labor force far less educated and motivated than at Sewickley.  They might have been enticed by the candidates pushing the envelope and skating close to the edge of law and corporate propriety, but have misjudged how far he crossed the line.

This happens all the time.  Baseball managers go bust in one season. CEOs who transfer from private to non-profit agencies don’t get the cant and ‘mission’ and in driving the bottom line to the floor send the rats scurrying from the ship. Church pastors are found with their hands in the till and their hands down little boys pants. Army colonels on their way to the Pentagon are caught in delicto flagrante with the hot major in Supply; or who are so addled with anger and vendetta over the loss of a company that they do something stupid and more soldiers are killed.

The point is, you never know, and you pay for what you think you are going to get, not what you may actually get. Given the relative subjectivity of the employment decision, it is not unusual that decisions on benefits packages are even more subjective.

Attempts to apply objective criteria to salary levels will always fail.  If a company is failing, although there may be textbook cases and historical evidence to suggest time to profitability, no two companies are exactly alike.  Furthermore, the amount of money available to rectify structural problems may be limited.  Finally, as above, the wrong rider might be in the saddle.  Projections to profitability are almost always wrong.

All this corporate sabermetrics, however, is valid only after an new CEO his hired – that is, his salary increases may be tied to some objective criteria – but the question of how much to offer him to get him to join the firm is another question altogether.

If the board of directors has faith in a candidate based on his past performance, personality, professional and social contacts, intelligence, and machismo; and if they feel that because of his attractiveness he has many suitors, then they can and should pay whatever it takes to hire him, so long as his benefits package does not break the bank.

So, under these conditions, is a benefits package of $10 million too high? One of $100 million? One of a billion over three years?  No CEO salary is too high if the there is money in the till and confidence in the minds of the board.  Private corporations are not like municipal government where public service employees are hired for life as long as they are loyal and show up. If the new CEO turns out badly, he can be cashiered on two weeks notice.  High-stakes capitalism is a risky business, and sometimes investments turn out badly.  You simply turn the page.

The non-profit world is more regulated because of its many government contracts.  Salary levels are rigorously controlled and tied to salary history rather than performance.  If you made $50,000 last year in your last government contracted job, you cannot be paid $100 thousand, regardless of your unique contributions to the firm.  A CEO of a large profit agency in Washington once tried to do this and found ways around the rat’s nest of public regulations.  The candidate had exactly the right skills to manage a key division of the company and bring it back from the dead.  He had the technical background, the agility, the political savvy, and the intelligence to turn the whole company around. Yet at the relatively low salaries the non-profit was traditionally offering, he would have paid them no mind whatsoever.  However with the enhanced benefit package devised by the CEO, he was at least listening.

The howls from the staff were wild and savage.  As a man he was throwing off the new initiative to redress female salary inequality.  As a corporate outsider he was jumping many pay grades above the most senior staff in the organization.  Morale would become frayed, initiative dampened, etc. etc. Worst of all, his ‘outrageous’ salary was an affront to the ‘mission’ of the company.  How could he be paid a Wall Street salary when there were poor, starving children in Africa?

In the private sector, no one cares about any of this nonsense; and companies are free to spend their money on whomever and however they want.  Risk is implicit in any decision.

So why the outcry over executive salaries? Why, for example is the invidious comparison made between the salary of the CFO responsible for a portfolio of hundreds of millions of dollars in a volatile market and the stock-and-errand boy.  The fact that the CFO makes 100 times as much is completely irrelevant.  The stock-and-errand boy should be paid a salary commensurate to his responsibilities and the demands of the market independent of any other job category.  What relevance does the smaller income disparity among job levels in Sweden have to do with corporate America?  Different culture, different economic system, different history, and different social contract.

I had a boss once who was a whiz at winning government contracts; and she was rewarded for her performance.  The reality of his department, however, was far different. Everyone who rowed in her slave ship was tired, disaffected, and angry.  Her model – work ‘em to death; the line of job applicants goes out the door – was good for short-term profits.  While her market analysis was right, and that the supply of bright young things did indeed outstrip demand, she did not count on the intangible of reputation.  Word got around that she was as unforgiving as Simon Legree and an arrogant, dismissive, and intolerant manager who ruled by fear and intimidation.   The line outside the door dwindled.  Those employees who secured new employment put molasses in her gas tank, went viral in their condemnation, and joined class action lawsuits against her.

The board of directors had missed the downside of her very appealing drive, ambition, and work ethic. After five years of rising profits, the curve went south, trusted employees left the firm, and she was out on the street in months.

Her high salary was worth it to the company for five years, but the irreparable damage she did to corporate image and integrity was incalculable.  In other words, her salary which was many times that of any one under her and as high as anyone but the President paid dividends. No one on the board batted an eyelash at the One Percent protestors in the park.  They paid her what she was worth, rode her coattails for five years, then took a loss.  Her replacement was paid even more.

Corporate enterprise is a risky business; and companies should be free to do what they please and either reap the benefits or suffer the consequences. No matter who has a say in executive pay decisions – top management, boards of directors, or stockholders – decisions will always be subjective and given to the whims of the marketplace.

‘There are no whiners in private industry’ said R. Whitfield Hunt III, one of the new breed of laissez-faire capitalists of the early 20th century who were too busy building America to notice anything else but expansion and profits.  “Whiners”, he said, referring to the progressives of the era, “should go back to running soup kitchens and managing bread lines.  Up here this is America.”

Today’s capitalism is a rather meek version of yesterday’s muscular enterprise.  There has been some softening of the edges and a lot more government regulation; but it still remains a bare-fisted arena. The unions have  been destroyed, the collaboration between corporate America and Wall Street restored; the consumer cannily manipulated by the use of big data and savvy advertising; and the landscape continually altered by sharp merger-and-acquisition lawyers who find ways around Congress just as successfully as they have in the past. 

Therefore, don’t look for any corporate mea culpas over executive pay anytime soon; and expect the whining from the One Percenters to die down and be forgotten.  The American capitalist juggernaut is back after some years of downturn. Lessons were learned, especially how to outflank, outrun, and outthink government, and business is thriving.  As Whitfield Hunt said, “Up here this is America.”

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